Woman taking a frothy bath

Most investors need bonds as a portfolio anchor. For some, it’s the psychology of capital preservation. For others, it’s the necessity of a predictable income flow.

As equities shoot to new highs, many investors still have 2008–2009 in the back of their minds and prefer the safety of bonds. But they are afraid of something else: duration risk — the impact on the capital value of a bond should overnight rates rise.

That makes life difficult for capital preservationists. They prefer GIC and short-term bond ladders, because they know they will get their capital back and earn a fixed return. That comes at a price, of course, because there are embedded costs in a GIC or direct bond purchase that aren’t directly disclosed.

Do preservationists really avoid capital loss? Quant manager Clifford Asness, talking about his top 10 investment peeves, thinks not:

“Many advisers and investors say things like, ‘You should own bonds directly, not bond funds, because bond funds can fall in value but you can always hold a bond to maturity and get your money back.’ Let me try to be polite: Those who say this belong in one of Dante’s circles at about three and a half (between gluttony and greed).”

He adds that the critics of bond funds and ETFs “often also assert that another negative feature of bond funds is that ‘they never mature’ whereas individual bonds do. That’s true . . . but the real irony is that it’s only true for individual bonds — not the actual individual bond portfolio these same investors usually own. Investors in individual bonds typically reinvest the proceeds of maturing bonds in new long-term bonds (often through the use of a ‘laddered portfolio’). In other words, their portfolio of individual bonds, each of which individually has the wonderful property of eventually maturing, never itself matures.”

Despite folk wisdom, there is no safe way to avoid risk. There are only behavioural ruses that play down risk.

Scot Blythe is a Toronto-based financial writer.
Originally published on Advisor.ca